The CFA Society of the UK (CFA UK) registered opposition to new guidelines for research commissions proposed by UK regulators. In its 32-page comment letter, which included a white paper on the research market, the CFA UK criticized the Financial Conduct Authority’s (FCA’s) content-based approach to regulating what research is eligible to be paid with client commissions, arguing for a use-based approach permitting anything that contributes to investment decision-making. However, it agreed with the proposed ban on commission payments for corporate access with the proviso that the volume of corporate access should not be diminished by the new regulations. The CFA UK recommended against a total ban on the use of client commissions for research.
The CFA UK, whose membership comprises approximately 10,000 investment professionals from both the sell-side and buy-side, took issue with the FCA’s definition of research eligible to be paid with client commissions. The FCA and its predecessors have maintained a tighter research definition than U.S. regulators, requiring that research contain ‘original thought’. In its new proposed regulation articulated in Consultation Paper 13/17, the FCA underscores its definition by characterizing it as requiring ‘substantive research’.
The CFA UK attacks the FCA’s content-based approach to eligible research: “…we do not support a content-based approach to the definition of research. We favour a use-based definition requiring investment managers to make reasonable, evidence-based assessments of the extent to which different research products and services have contributed to investment decision-making across specific investment vehicles.”
The awkward fact, however, is that the UK definition of research has been content-based for the last 8 years. As we have noted previously, the specific research definitions in CP 13/17 are no different from the previous definitions. Rather, what CP 13/17 is doing is clarifying what the FCA believes meets its previous standards. CP13/17 reflects the FCA’s umbrage that asset managers have been largely ignoring the existing standards, most blatantly with corporate access but also through payments for expert networks and other forms of primary research.
The CFA UK argues that the FCA’s definition is too restrictive: “By focusing only on the content of the material, the proposed definition may inappropriately narrow the scope of services available to be obtained by commissions to only research reports and conclusions in their final form. This approach ignores the use of commissions to obtain building blocks of information or raw data that can be used by investment managers to form their own independent strategies or analysis.”
Although corporate access is an important building block to investment decision-making, the CFA UK wavers in its support for corporate access. Tucked away in an appendix is the CFA UK’s admission that it agrees that paying for corporate access from dealing commission should be disallowed. The CFA UK’s tepid support is preceded by an extensive ode to the virtues of corporate access and caveated with the proviso that the FCA’s payment ban should not diminish the volume of corporate access.
It is unlikely that the volume of corporate access in the UK will diminish because, as the CFA UK points out in its paper, the investment banks will be quick to game the new regulation. The CFA UK (many of whose members work in investment banks) expects that banks will continue to arrange meetings with company management as a ‘free’ service for their largest clients. “Corporate access will persist in all but name, but will be managed as a ‘free’ service’”.
We suspect that the banks’ response will be more subtle, incorporating analyst input into the corporate access process and leveraging the eligibility of conferences in order to ensure that corporate access services are ‘substantive’.
As we have noted, there are also new startups offering innovative responses to the proposed regulation. One example is Ingage, a brand new cloud-hosted platform designed to intermediate corporate investor relations with institutional investors. While the CFA UK supports new initiatives like Ingage, it cautions that asset managers will be loath to pay for corporate access from their own wallets: “However, it is worth noting that the general anxiety about being seen to pay for any form of corporate access – even where payment is made exclusively from an investment firm’s own resources – means that investment firms are cautious about subscribing for such services.”
The CFA UK also cautions the FCA against a total ban on research commissions, arguing that it would be disruptive to markets, uncompetitive for the UK asset management industry relative to other domiciles, and disadvantage smaller asset managers and independent research providers. While it acknowledges that smaller asset managers and research providers might recover, it raises the risk of permanent damage to competition within the asset management industry and the research market.
The submission also includes a review of academic literature on the value of research and the results of the survey on research the CFA UK conducted last fall. The survey provided strong support for improved disclosure of research costs and more explicit pricing of service levels by research providers (something over which the FCA has little control). Interestingly, the survey was most negative about two of centerpiece recommendations made by the CFA UK: better benchmarking of external research costs and research budgeting.
The CFA UK’s submission is substantive and, given the organization’s stature, will be given close scrutiny by the FCA. Its arguments against a content-based research definition are forceful and well-reasoned. Nevertheless, it is unlikely the FCA will move to a use-based definition as the CFA UK proposes.
First, there is the matter of regulatory inertia. The current content-based research definition has been in place since 2006. Further, the FCA is incensed that asset managers have effectively ignored the rules with regard to corporate access.
Second, a use-based research definition opens the gates widely to a variety of services that the regulators do not consider research, most notably market data. Market data vendors can rightly argue that their services are valuable inputs to investment decisions and therefore should be eligible to be paid through commissions. However, the FCA explicitly cited examples where asset managers were paying in full for market data services with client commissions as abuses of the current regime. The CFA UK wisely glossed over this issue in its submission.
Corporate access is also problematic for the CFA UK’s position. The submission states that there is common agreement that corporate access is valuable. If so, why not support it under a use-based definition? The reasons given (lack of transparency, difficulty in determining value) are no different than for any other bundled research product.
Which leads to a further question: if the CFA UK supports a ban on commission payments for bundled corporate access, why not support a ban on commission payments for all bundled research? The CFA UK’s answer is that a total ban would be too disruptive. However, if the proposed ban on commissions for corporate access goes smoothly, perhaps the FCA will be emboldened to move to a broader injunction. In other words, CP 13/17 is a test case for a broader ban. To be continued.